Choice overload: What the chocolate test means for investors

Commentary by Robin Bowerman, head of market strategy and communications for Vanguard in Australia.

Imagine being asked to choose from a display of 30 different chocolates and 24 flavours of jam. Chances are you would have trouble making a choice and perhaps might end up without a single chocolate or jar of jam.

Psychologists Sheena Iyengar from Columbia University and Mark Lepper from Stanford University once conducted tests that examined the responses of participants when asked to choose from an extensive range of chocolates and jams.

Their findings, published 16 years ago in a classic research paper – When choice is demotivating: Can one desire too much of a good thing? – have significant implications for today's investors facing a seemingly ever-growing line-up of options of where and how to invest their money.

Iyengar and Lepper wrote: "Our findings demonstrate that the offer of overly extensive choices in relatively trivial choice-making contexts can have significant demotivating effects." Then the psychologists say that the "phenomenon of choice overload" may be "further exacerbated" in other contexts such as making investment decisions.

Unsurprisingly, participants in the chocolate test reported enjoying being able to choose from 30 chocolates more than from a limited choice of six. Yet despite this initial greater enjoyment, they were more dissatisfied and regretful about their eventual choices. And, in fact, they were much less likely to make any choice at all – preferring money for their participation in the test rather than chocolates.

Thanks largely to the initial work of Iyengar and Lepper, behavioural economists today commonly use the term "choice overload" to describe the huge array of investment choices.

In a recent investment commentary, the director of the Vanguard Centre for Investor Research, Steve Utkus, wrote that individuals find too many choices perplexing and demotivating. "Too many options made shoppers disinclined to like or buy," he noted, alluding to the chocolate test.

In short, an excess of investment choice can lead to more investors making choices that are not in their best interests but also to investment inertia. If feeling unable to make a choice because so much is on offer, investors often do nothing.

These principles include: Setting clear and appropriate investment goals, developing appropriate long-term strategic asset allocation for their portfolios to achieve those goals (within their risk tolerance) and placing a high priority on minimising investment management costs.

Such investors – often acting with the guidance of an adviser – are likely to find that many of the myriad of investment options on offer simply won't make the cut of their carefully created portfolios.

Some investors deal with choice overload by investing in a low-cost, diversified fund with an appropriate asset allocation for their circumstances. And others hold the core of their portfolios in a range of low-cost traditional index funds or exchange-traded funds (ETFs) and satellites of favoured direct shares or actively managed funds, again in accordance with their chosen asset allocations.

A well-thought-out, long-term approach to investing should also help discourage emotional reactions to short-term market movements – and, in so doing, prevent rushed, ill-considered decisions about what to pick from the investment shelf.

Important information:

This article is designed for use by, and is directed only at, persons resident in the UK.

This article was produced by Vanguard Asset Management, Limited. It is for educational purposes only and is not a recommendation or solicitation to buy or sell investments.

The value of investments, and the income from them, may fall or rise and investors may get back less than they invested.

Any projections should be regarded as hypothetical in nature and do not reflect or guarantee future results.

The opinions expressed in this article are those of the individual author and may not be representative of Vanguard Asset Management, Ltd.

Issued by Vanguard Asset Management, Ltd, which is authorised and regulated in the UK by the Financial Conduct Authority.